Chapter 3
Examining and Mastering Question Types
IN THIS CHAPTER
Exploring the composition of Series 7 exam questions
Analyzing the purpose and intent of a question
Identifying the correct answer
Mastering the process of elimination
Yes, I know, I know: “Why can’t they just ask regular questions?” This problem has perplexed Series 7 test takers throughout the ages (all right, maybe not, but it does bug me). The test designers have riddled the old pick-the-best-answer questions with all kinds of pitfalls. The people in charge want you to choose combinations of correct answers and pick out exceptions; they expect you to pull numbers from balance sheets and apply complex formulas; and, as if you don’t have enough to worry about, they even give you extraneous information to try to trip you up. Sheesh!
In this chapter, I introduce you to the types of questions to expect on the Series 7 exam, and I show you how to analyze the facts in the questions and identify what the examiners are really testing you on. I also show you how to use the process of elimination to find the right answer and, if all else fails, how to logically guess the best answer.
You should also be aware that in its effort to make securities exams more fair to all test takers, FINRA has decided to weight the questions according to levels of difficulty. What this means to you is that for the most part, easier questions (or what FINRA deems to be easier questions) will be worth less than the average question and more difficult ones will be worth more than average.
Familiarizing Yourself with Question Formats
Because of the number of questions that could be asked, the Series 7 exam is a beast of a test that poses questions in many different ways. You have to deal with multitiered Roman numeral nightmares, open- and closed-ended sentences, and killers like except and not. In this section, I show you how the examiners phrase the questions and how they can trip you up if you aren’t careful.
Working with the straight shooters: The straightforward types
Straightforward question types include a group of sentences with the facts followed by a question or incomplete sentence; you then get four answer choices, one of which correctly answers the question or completes the idea.
Closed-stem questions
You’ll find more closed-stem questions than any other question type on the Series 7 exam, so you’d better get a handle on answering these babies, for sure. Thankfully, closed-stem questions are fairly run-of-the mill. They begin with one or more sentences containing information and end with a question (and, appropriately enough, a question mark). The question mark is what makes closed-stem questions different from open-stem questions, which I discuss in the next section. Your answer choices, lettered (A) through (D), may be complete or incomplete sentences. Here’s a basic closed-stem question.
Mr. Bearishnikoff is a conservative investor. Which of the following investments would you recommend to him?
(A) Buying put options
(B) Buying long-term income adjustment bonds
(C) Buying common stock of an aggressive growth company
(D) Buying Treasury notes
The right answer is Choice (D). The first sentence tells you that Mr. Bearishnikoff is a conservative investor. This detail is all the information you need to answer the question correctly, because you know that conservative investors aren’t looking to take a lot of investment risks and that U.S. government securities such as Treasury notes (T-notes) are considered the safest of all securities — they’re backed by the fact that the government can always print more money to pay off the securities that it issues.
Of course, sometimes the phrasing of the answer choices can help you immediately cut down the number of feasible answer choices. For instance, Mr. Bearishnikoff would probably balk at investing in an aggressive growth company, which certainly doesn’t sound stable or safe. Check out the section titled “Picking up clues when you’re virtually clueless: The process of elimination” for details on raising your odds of answering questions correctly.
By the way, the you in the question refers to you on your good days, when you’re considerate and rational and have had a sufficient amount of sleep. Mr. Bearishnikoff probably wouldn’t appreciate any rogue-elephant investing, even if you think he should be more daring. The question also assumes normal market conditions, so don’t recommend a different investment because you think the government is going to collapse and T-notes are going to take a dive. Just accept the conditions the problem presents to you.
Be careful to focus only on the information you need to answer the question. The Series 7 exam creators have an annoying tendency to include extra details in the question (such as the maturity date, coupon rate, investor’s age, and so on) that you may not need. See “Focusing on key information,” later in this chapter, for some tips on zeroing in on the necessary info.
Open-stem questions
An open-stem question poses the problem as an incomplete sentence, and your mission, should you choose to accept it, is to complete the sentence with the correct answer. The following example shows how you can skillfully finish other people’s thoughts.
The initial maturity on a standard option is
(A) three months
(B) six months
(C) nine months
(D) one year
The answer you want is Choice (C). Options give the purchaser the right to buy or sell securities at a fixed price (see Chapter 12). Options are considered derivatives (securities that derive their value from another security) because they’re linked to an underlying security. Standard options have an initial maturity of nine months. On the other hand, Long-Term Equity AnticiPation Securities (LEAPS) may have initial maturities of one, two, or three years. But this example question asks about a standard option; therefore, you don’t assume that it’s a LEAP.
The preceding example is quite easy. Anyone who has been studying for the Series 7 exam should know the answer. However, what makes the Series 7 so difficult is that the exam is loaded with so many date-oriented details. Not only do you have to memorize the initial maturities of all the different securities, but unfortunately (and believe me, I feel your pain), you also have to remember a truckload of time frames (for example, accounts are frozen for 90 days, new securities can’t be purchased on margin for 30 days, an options account agreement must be returned within 15 days after the account is approved, and so on).
Date-oriented details are excellent material to include in your flash cards. See Chapter 2 for more study suggestions.
Encountering quirky questions with qualifiers
To answer questions with qualifiers, you have to find the “best answer” to the question. The qualifier keeps all answer choices from being correct because only one answer rises above the rest.
Working with extremes: Most, least, best
Recognizing the qualifier in the question stem and carefully reading every single answer choice are very important. Check out the following example.
Which of the following companies would be MOST affected by interest rate fluctuations?
(A) SKNK Perfume Corp.
(B) Bulb Utility Co.
(C) Crapco Vitamin Supplements, Inc.
(D) LQD Water Bottling Co.
The answer is Choice (B). Although all companies may be somewhat affected by interest rate fluctuations, the question uses the word most. If interest rates increase, companies have to issue bonds with higher coupon (interest) rates. This higher rate, in turn, greatly affects the companies’ bottom lines. Therefore, you’re looking for a company that issues a lot of bonds. Utility companies are most affected by interest rate fluctuations because they’re highly leveraged (issue a lot of bonds).
Making exceptions: Except or not
When a question includes the word except or not, you’re looking for the answer that’s the exception to the rule stated in the stem of the question. In other words, the correct answer is always the false answer. The question can be open (as it is in the next example) or closed.
Right off the bat, look for an except or not in the stem of every question on the Series 7. Many students who really know their material accidentally pick the wrong answer on a few questions because they carelessly miss the except or not.
Take a look at the following exception problem.
A stockholder owns 800 shares of WHY common stock. WHY stockholders were given cumulative voting rights. If there are three vacancies on the board of directors, stockholders can cast any of the following votes EXCEPT
(A) 800 for one candidate
(B) 800 for each candidate
(C) 2,400 for one candidate
(D) 900 for each candidate
The answer you’re looking for is Choice (D). Cumulative voting rights give smaller stockholders (not height-wise, but in terms of the number of shares they own) an easier chance to gain representation on the board of directors because a stockholder may combine his total voting rights and vote the cumulative total in any way he wants. Here, the stockholder has a total of 2,400 votes to cast (800 shares × 3 vacancies = 2,400 votes).
In this example, you may be tempted to select Choices (A), (B), or (C), any of which would be correct if you were asked for the number of votes this stockholder could cast. For example, the stockholder can use 800 shares to vote for only one candidate (Choice A) — he doesn’t have to use all 2,400 votes. Choice (B) is another possible voting arrangement because nobody said the stockholder has to use all his votes for one candidate. Choice (C) is an option because the stockholder has a total of 2,400 votes to cast. In this question, however, you’re looking for the number of votes the stockholder can’t cast because the word except in the question stem requires you to find a false answer. Therefore, Choice (D) is the correct answer because in order to cast 900 votes for each candidate, the stockholder would need a total of 2,700 votes (900 × 3).
If you’re one of the unlucky people who get an “all of the following are false except” question, you have to find the true answer. Don’t forget, two negatives in a sentence make a positive statement. You may want to try rephrasing the question so you know whether you’re looking for a true or false answer.
Roman hell: Complex multiple choice
Yes, the Series 7 exam creators even sneak complex (two-tiered) Roman numeral questions in on you. They can pose the question by asking you to put something in order, or they can ask you to find the best combination in a series of answer choices. To make things even more enjoyable, sometimes they even add except and not to the question (see the preceding section).
Imposing order: Ranking questions
To answer a ranking question, you have to choose the answer that places the information in the correct order — for example, first to last, last to first, highest to lowest, lowest to highest, and so on. Check out the following example.
In which order, from first to last, are the following actions taken when opening a new options account?
- Send the customer an ODD.
- Have the ROP approve the account.
- Execute the transaction.
- Have the customer send in an OAA.
(A) I, II, III, IV
(B) II, I, IV, III
(C) III, I, II, IV
(D) I, III, II, IV
The correct answer is Choice (A). Wasn’t it nice of me to arrange all the answers in order for you? Because option transactions are so risky, the customer has to receive an options risk disclosure document (ODD) prior to opening the account. Statement I has to come first, so you can immediately eliminate Choices (B) and (C), giving you a 50 percent chance of answering correctly. After the client receives the ODD, the registered options principal (ROP) needs to approve the account before any transactions can be executed; II has to come before III, so you can finish the problem here — the answer is Choice (A). Last but not least, the customer signs and returns an options account agreement (OAA) within 15 days after the account is approved by the ROP.
Taking two at a time
The Roman numeral format also appears on the Series 7 with questions that offer two answer choices as the correct response. In these types of questions, you choose the responses that best answer the question.
Which TWO of the following are the minimum requirements for an investor to be considered accredited?
- An individual with a net worth of $500,000
- An individual with a net worth of $1,000,000
- An individual who earned $200,000 per year in the most recent two years and has a reasonable expectation of reaching that same level in the current year
- An individual who earned $300,000 per year in the most recent 3 years and has a reasonable expectation of reaching that same level in the current year
(A) I and III
(B) I and IV
(C) II and III
(D) II and IV
The correct answer is Choice (C). Statements I and II both deal with net worth; III and IV deal with earnings. Therefore, you’re dealing with two questions in one; to be accredited, the answer to at least one of these two questions must be satisfactory:
- What is the individual’s minimum net worth?
- What is the individual’s minimum income?
To be considered an accredited (sophisticated) investor, the minimum requirement is a net worth of $1,000,000 and/or a yearly income of $200,000 in the most recent two years, with a reasonable expectation of reaching that same level in the current year. If the word minimum were not used in the question, answer IV would also be correct.
A little mystery: Dealing with an unknown number of correct statements
In the preceding section, the question states that only two responses can be correct. The following question may have one, three, or four correct answers. You can recognize this type of question simply by glancing at your answer choices. To make the problem more difficult (don’t hate me, now), I add an except because I’m feeling really good about you, and I just know you’re up to it.
All of the following are considered violations EXCEPT
- rehypothecation
- commingling
- odd lot transactions
- forward pricing
(A) I only
(B) II only
(C) I, III, and IV only
(D) I, II, III, and IV
The correct answer is Choice (C). The only violation among the choices listed is commingling. Commingling occurs when a broker-dealer combines a customer’s account with his own or combines a customer’s fully paid securities with margined securities. (Chapter 16 fills you in on rules and regulations.)
You’re looking for the choices that are not violations, so you want to identify the actions that are allowed. If you eliminate commingling, Roman numeral II, your choices are A (I only) or C (I, III, and IV only). You know that I is correct because it’s in both answer choices, so you need to evaluate only III and IV. (You have to check only one of these because you know that if III is correct, IV must be as well; if III is false, so is IV.) Odd lot transactions (III) are ones for fewer than 100 shares (a round lot) and are okay. Forward pricing (IV) is what mutual funds do with orders placed by investors, allowing them to purchase or sell at the next price (usually at the end of the day), which is also okay. Choice (C) is correct because it’s the only one that lists all three correct choices (I, III, and IV).
Looking at exhibits: Series 7 diagram questions
The Series 7 exam also gives some exhibit questions, which may include newspaper clippings, option prices, bond prices, trading patterns, a specialist’s book, income statements, balance sheets, and so on. Out of the exhibit questions you get, some of them just require you to find the correct information; others require a little calculating. I wouldn’t be too concerned about them if I were you, because most of them are quite easy.
Take a look at the following problem.
© John Wiley & Sons, Inc.
What is the working capital of GHI Corp.?
(A) $7,000
(B) $7,000,000
(C) $9,000
(D) $9,000,000
The answer you’re looking for is Choice (D). This example accurately portrays the difficulty level of most of the exhibit questions on the Series 7 exam. After you remember the formula for working capital (see Chapter 13), you simply have to find the information you need — the current assets and current liabilities — on the balance sheet so you can answer the question:
You may wonder why the answer is in millions instead of thousands. Notice that the top of the balance sheet says “in thousands,” which tells you that you have to multiply the numbers in the balance sheet by 1,000.
When you answer exhibit questions, take care not to miss labels like “in thousands” in headings or scales on a graph that would change your answer. Almost nothing is worse than missing a question that you know how to figure out because you carelessly overlook something right in front of you.
The following question has you locate information on call options.
© John Wiley & Sons, Inc.
What is the time value of a CDE Nov 65 call?
(A) 4.00
(B) 3.25
(C) 3.00
(D) 2.40
The right answer is Choice (B). This question involves options (see Chapter 12 for calculations and more information). The first step is to find the premium for the CDE Nov 65 call in the exhibit. To accomplish this, line up the 65 strike price with the Nov expiration month; you find it in the third row of data. Follow that row over to the fifth column to get the premium for the Nov 65 call. In this case, it’s 6.75. Next, use the following formula: P = I + T, where P = premium, I = intrinsic value (the in-the-money amount), and T = time value (how long an investor has to use the option).
First, enter the premium into the equation. Next, you have to determine the intrinsic value (how much the option is in-the-money). Call options go in-the-money when the price of the stock is above the strike price. The stock price is 68.50 (left column) and the strike price is 65, so the option is 3.50 in-the-money (68.50 – 65 = 3.50). After placing those two numbers (6.75 and 3.50) in the equation, you see that the time value has to be 3.25:
Shredding the Questions: Tips and Tricks
In Chapter 2, I give you general exam proficiency tips. In this section, I show you how to improve your analysis of topic-specific Series 7 questions. I also provide you with more sample exam questions to further demonstrate the art of choosing the correct answers.
Focusing on key information
The Series 7 exam questions can be particularly difficult if you rush through the exam and miss details that change the meaning of the question.
When you first start taking practice exams, read through the question to determine what’s being asked; then go back to the beginning of the problem to identify the key facts and underline and/or highlight them. Marking the questions may seem time-consuming when you first begin to study, but if you get into the habit of picking out key words in each question, zoning in on the important information should be second nature by the time you take the test. Of course, you can’t underline items on the computer screen at the testing center (the test center administrators may get upset if you write on the computer screen). So instead, if you find yourself getting distracted by useless information, use the scrap paper or dry erase board to write down the information you do need.
This example zeroes in on the essential information.
A 55-year-old investor purchases a 6 percent DEF convertible mortgage bond at 90 with 10 years until maturity. If the bond is currently trading at 97, what is the current yield?
(A) 5.72%
(B) 6.00%
(C) 6.19%
(D) 6.67%
The correct answer is Choice (C). When determining the current yield of a bond, all you need is the market price of the bond and the coupon (interest) rate (see Chapter 7). The fact that the investor is 55 years old or that the bond is a convertible mortgage bond that was purchased at $900 (90 percent of $1,000 par) with 10 years until maturity means nothing in terms of determining the answer. Underline or highlight what you do need (6 percent, 97, current yield) so you don’t get distracted.
To determine the current yield, divide the annual interest by the market price. The annual interest is $60 (6 percent of $1,000 par) and the market price is $970 (97 percent of $1,000 par):
To avoid confusion when faced with a math problem, read the stem of the question to determine what’s being asked; before you consider the rest of the question, jot down the formula you need to calculate your answer.
Answer me this: Picking the correct answer
The Series 7 exam is a practical, multiple-choice exam. The correct answer has to be one of the choices. This setup means you don’t have to provide the correct answer; you just have to recognize it when you see it.
Picking up clues when you’re virtually clueless: The process of elimination
When you don’t straight-out know an answer, your approach can definitely make the difference between passing and failing the exam. Your best strategy may be eliminating the wrong answers. In theory, you should be able to eliminate, one by one, three incorrect answers for each question.
Even if you can’t eliminate three incorrect answers, you’ll certainly be able to eliminate one or two answers that are definitely wrong. Don’t try to guess the right answer until you’ve axed as many wrong answers as you can. Obviously, if you can get the choices down to two potential answers, you have a 50-50 chance of answering correctly.
For an answer choice to be correct, every aspect has to be correct, and the selection has to specifically answer the question that’s asked. As a rule of thumb on the Series 7 exam, a more-precise answer is correct more often than a less-precise answer, and a longer answer usually (but not always) prevails over a short answer.
If a response is potentially correct, write T for true next to the answer in your practice exam, and if a response is wrong, eliminate it by writing F for false next to the answer. If you do this step correctly, you should end up with three Fs and one T, with T indicating the correct answer. Or, if the question is looking for a false answer, you should end up with three Ts and one F (see the earlier section “Making exceptions: Except or not” for more info on this scenario). On the actual test, you can write the letters A through D on your scrap paper or dry erase board and mark the answer choices appropriately.
Always look to eliminate any wrong answers that you can. Pay attention to the wording, and get rid of choices that simply sound wrong or make statements that are too broad or absolute. If you’re still undecided, use your scrap paper or dry erase board to write down the question number and the answer choices that remain. Take your best guess and mark the answer for review. When you review, look at your scrap paper or dry erase board to help you zone in on your potential answers. Change your answer only if you’re sure you made a mistake.
Stop opposing me: Dealing with opposite answers
If you see two opposing answer choices, only one can be right. Traditionally, in practical exams like the Series 7, when you see two answer choices that are complete opposites, the exam creators are trying to test your knowledge of the correct rule, procedure, or law, so one of those opposing choices is most likely the correct answer. Take a look at the following example.
Which of the following is TRUE of UGMA accounts?
(A) There can be only one minor and one custodian per account.
(B) There can be more than one minor and one custodian per account.
(C) Securities can only be purchased on margin.
(D) They must be set up for children who have reached the age of majority.
The answer you want is Choice (A). Notice that Choices (A) and (B) oppose each other. If you have two opposing answers, in almost all cases, one of them is the right answer. Therefore, you can ignore Choices (C) and (D), which gives you a 50 percent chance of getting the answer right. Uniform Gifts to Minors Act (UGMA) accounts are set up for minors who are too young to have their own accounts. Each account is limited to one minor and one custodian. (See Chapter 16 for details on custodial accounts.)
Facing Roman numerals: Not as hard as you think
Complex (two-tiered) multiple-choice questions, with both Roman numerals and letters, can be really frustrating because they usually signal the test taker (you) that you need more than one correct answer. Well, today’s your lucky day, because I show you a shortcut that can help you blow these questions right out of the water.
Traditionally, the first tier of these types of questions gives you several statements preceded by Roman numerals; the second tier (preceded by letters) provides you with choices about which of those statements are correct. Fifteen different combinations of I, II, III, and IV are possible (16 if you count “none of the above,” which is almost never correct), but each problem can list only four of them in the answer choices. Because of the limited answer choices, you may not have to evaluate every statement — certain combinations of Roman numerals may be logically impossible.
Read the question carefully, and then mark T for true or F for false next to the Roman numerals to indicate whether they’re correct answers to the question. If a Roman-numeral statement is correct, circle that number in the choices that follow the letters in the second tier. If the Roman-numeral statement is false, all the letter answers that include that numeral must also be false, and you can cross them out. If you’re really lucky, three of the Roman numerals can be eliminated right away, leaving you with one answer choice.
Look over this Roman numeral question.
Which of the following is TRUE of the 5% Markup Policy?
- It covers commissions charged to customers when executing trades on an agency basis.
- It covers markups on stock sold to customers from inventory.
- It covers markdowns on stock purchased from customers for inventory.
- Riskless and simultaneous transactions are covered.
(A) I and IV only
(B) IV only
(C) II and III only
(D) I, II, III, and IV
The correct answer is Choice (D). The 5% Markup Policy applies to nonexempt securities sold to or purchased from customers. This situation is one where you should look at the Roman-numeral statements and pick out those that you know answer the question. For example, if you know statement I is right (which it is), put a T (for true) next to it. Next, look at Choices (A), (B), (C), and (D) and eliminate Choices (B) and (C), because neither one includes the Roman numeral I. Because both answers that remain, (A) and (D), include the Roman numerals I and IV, you don’t even have to bother reading statement IV — it’s in both remaining answers, so you know it has to be true. Write T next to the Roman numeral IV. If you know that either statement II or III is correct (which they both are), the answer has to be Choice (D) because it’s the only one that lists all the correct choices.
Don’t make the same mistake twice
When studying for the Series 7 exam, the practice exams can help you pinpoint your weaker areas of knowledge. The questions you answer incorrectly can be your best learning tools if you thoroughly review the explanations for each wrong answer. You may be tempted to jump from one practice exam to the next without taking adequate time to review your wrong answers. Don’t do it! If you put the effort into finding out why your choices are wrong when you’re practicing, you’re less likely to repeat the same mistake on the Series 7 exam, when it really counts.